Even with 66 satellites launched, a high-flying company plunges to earth

Beginning in mid-1997, Iridium World Communications successfully launched 66 satellites, enough to provide wireless telephone coverage around the globe. This dazzling display of technological prowess ushered in a new era of communications in which world travelers could pack a wireless telephone, and be reachable from a single telephone number, whether they were in Tokyo, New York, Bora Bora or Peru.

Two years later, the project came crashing back to earth. In August, the company defaulted on more than $1.5 billion in loans, and a few days later filed for bankruptcy protection, meaning that, under U.S. law, it can continue to operate while it makes plans to repay its huge financial debt to creditors. Perhaps tainted by Iridium's plunges, competitor ICO Global Communications also filed for protection.

The rise and fall of Iridium is a textbook case of how ambitious plans and initial success can sometimes go awry. While the company is still in operation, its prospects are dimmer. Iridium and ICO are stark reminders that even in the booming high-tech sector, the risks are high and success is hardly guaranteed. What seems like a promising idea can fall to a better one, and a pioneering company may eventually become a corpse on the information highway. The risk is not just to the company, but to investors. Iridium's stock, which hovered around $50 in November 1998 plunged to 3 1/16 on August 13th, when trading was halted by Nasdaq.

Iridium was hatched by Motorola, which is still the principal contractor and shareholder, with an 18 percent ownership. A consortium of 17 other companies have also invested, including Nippon Iridium Corp. (Iridium's second largest investor), PT Bakrie Communications Corp. of Indonesia, SK Telecom of Korea, Pacific Electric Wire & Cable Co., Ltd. of Taiwan, and Thai Satellite Telecommunications Co., Ltd. of Thailand-as well as the U.S. companies, Sprint Corp. and Raytheon Co.

So what went wrong? Observers point to a combination of high subscriber costs, and a technology that couldn't deliver on the company's vision. And they say that Iridium was blinded by the initial success of its satellite launches to the realities of the market, especially the growing clout of cellular technology. No company succeeds without a good understanding of its potential customer base. Iridium's principal failure was in misjudging its prospects: how many people could actually use the service, what those people needed, and what would put them off.

Iridium initially targeted a group of elite business travelers, global road warriors. But while many people travel in the course of their business, the numbers grow thinner in proportion to the miles traveled. Hence, in the U.S., for example, the number of people traveling within the country outnumber those traveling abroad. Of the rarified group of international business travelers, a smaller subset do so routinely. And a still smaller subset travel internationally so frequently, and so far afield, that they are candidates for universal wireless service. Who are these people? Bill Gates might qualify, along with the CEOs of other major corporations. Some super-salesmen scour the world for customers. And some academics travel the globe attending conferences and doing research. Surely, some of these people would be interested in a universal telephone number, and at least a few would purchase the service no matter what the cost.

As it turned out, that cost was high. Providing telephone service by launching satellites is not cheap and, not surprisingly, Iridium tried to recoup its investments by charging subscribers a high fee-between $2,000 and $3,000 in setup costs with the per minute price per call ranging from $2 to $9. For most people, even globetrotting investors, that's a high bill to pay, especially when an ordinary wired telephone can often be found right across the conference table.

Another problem had to do with the handsets. Iridium initially suffered from a problem that plagues many technology companies-the wishful thinking of the company's marketers did not match the company's technological clout. In this case, Iridium cut the ribbon on its service in November, 1998, capped by a $160 million marketing campaign. But the all important handsets were not ready, meaning that the company could not immediately deliver on its promise. Worse, the handsets did not work well either in cars or in buildings without a separate attachment. And in an era when cellular phones have shrunk to the size of a human hand, Iridium's telesets are the size of a brick and weighing 16 pounds. These factors forced Iridium to re-examine its target audience, looking for people whose occupations took them so far afield that telephone service was scarce. Among them: military officers, oil rig workers and mariners sailing the seas.

Herschel Shosteck, a communication consultant, has called Iridium's condition "tech-testosterone," meaning that the impressive technological achievement of successfully launching 66 satellites in such a short span blinded the company to the demands of the market. Roger Rusch, an aerospace consultant and former engineer with TRW told Newsweek magazine: "I think we'll end up a monumental engineering achievement that few people will use."

Others agree "Iridium's backers seem to have fallen to the classic 'sunk cost fallacy,'" wrote marketing professors Jagdisch N. Sheth and Rajendra Sisodia in the Wall Street Journal. "Having already spent billions of dollars and years of effort on the project, they were loathe to abandon it. Instead, they redoubled their efforts and spent more billions." The professors wrote that Iridium was so proud of its pioneering position as the first company to offer global satellite telephony that it missed the bigger picture. "Unless a company has strong patent rights (as in pharmaceuticals) or the ability to reduce costs and keep up with demand, the advantages of pioneering are fleeting and risks are many, especially with fast-moving technology." Indeed, a 1993 study showed that industry pioneers gained the marketshare in only four product categories out of 50. The software industry need only look as far as Microsoft to see how marketing prowess can bump engineering leadership.

Some industry observers have contrasted Iridium's approach with that of the cellular market which, in the late 1970s, had only the most modest expectations of success. Back then, Bell Labs predicted that cellular technology would attract only about 800,000 subscribers by the year 2000. Based partly on that prediction, AT&T, the giant American telecommunications company, never entered the business. And indeed, the early years of cellular mirrored that of Iridium. The service and equipment were costly, connections were unreliable, and service was limited to automobiles.

But hit by early financial losses, the cellular companies regrouped. The industry targeted new customers, including roving "road warriors" involved with sales and support, as well as women worried about their safety on the road. Cellular companies soon realized that ongoing service agreements, not one-time equipment purchases, represented where the money is and began selling handsets below cost. The cellular industry also realized that the key was not necessarily in charging a high permanent cost, but in encouraging more callers to make longer calls. Thus, fees have dropped and pricing packages have gotten as creative and complex for cellular service as for airline tickets. As a result, the cellular industry has grown by about 40 to 50 percent a year. With the year 2000 dawning, the U.S. alone will have 80 million subscribers. That's 100 times as many as the Bell Labs study had forecast.

Cellular is also competing on portability. The Swedish telecom company Ericcson, for example, introduced a model that it claims will work over five continents, in more than 120 countries.

Satellites for sale?

Will Iridium survive? In the United States, filing for bankruptcy is not always the end of the line. The company has, in American parlance, "filed for Chapter 11"-a statutory code in which a company keeps operating while trying to keep its creditors happy. In other kinds of bankruptcies, the company simply closes shop, sells its assets, and disappears from the face of the earth.

"Most countries do not allow the existing management and owners the role that they have in the United States," says Richard Diamond, of the Los Angeles law firm Danning, Gill, Diamond & Kollitz, LLP, which specializes in bankruptcy and reorganization. "Instead, a third-party trustee or management replacement comes in to run these companies. In the Canadian and British systems, large accounting firms often take on these responsibilities. Whereas in the United States, the existing management typically becomes the 'debtor in possession'-that is, a trustee entrusted to run the company. That means the same people who have brought its bankruptcy continue to operate it."

Still, this control only lasts so long. "By filing a Chapter 11, you by definition have put the company into play," says Diamond "That's because the company is now controlled by a bankruptcy court, and the company's creditors have a very large say in what ultimately happens. A creditors committee is formed, and while the company initially has the exclusive right to propose a reorganization plan, at some point the company can lose that exclusivity. Then, other interested parties can file their own proposed reorganizations, including a plan that proposes that the company be sold." (Indeed, at this writing, cellular telephone mogul Craig O. McCaw is considering a stake in Iridium, according to a New York Times report.)

While companies go bankrupt for many reasons, the large percentage can be attributed to a failure of management to watch their core businesses. Diamond says that over-expansion is typical. "Management has an initial success, they think their success can be expanded geometrically, but they don't understand that the size increase requires different systems and management structures. Most bankruptcies tend to be management failures as opposed to sudden changes in the economy, although there are certainly examples of both."

And the high-tech sector is hardly alone. In the U.S., retail operations go belly up the most. "Restaurants are your classic bankruptcy," he says. He predicts that the next U.S. industry segment to see a high bankruptcy rate is health care, because the organizations that pay the bill-the government and insurance companies-are clamping down on the high cost of medicine. Another area of failure is real estate development, which is very tied to economic fluctuations.

"By contrast, high-tech has a fair amount of bankruptcies but not so many reorganizations, probably because of the large investment of R&D. A lot of these companies just go out of business." Diamond sites a case he was recently involved with, a company that was developing a server that was capable of operating multiple operating systems in the same box. "They exhausted their venture capital at the point where they had just managed to get their first working prototype. So they had no funding left for marketing or to actually produce the product. For several months, the company sought new investment capital. When that proved unsuccessful, the company simply closed its doors-there's nothing left to it."

It's still to early to tell whether Iridium have the same destiny. The company has tried its best to put an optimistic face on a dire situation. Its website, for example, has user guides and coverage maps, testimonies and pricing plans, a company history and investor news. Word of the bankruptcy is buried in the press release section, which contains a statement from John Richardson, the 55 year old Australian who now heads the company: "We are confident that Iridium will emerge from this process as a stronger, more vibrant company in the telecommunications market." (Richardson certainly knows something about adversity-he has climbed Mt. Everest twice.) Nippon Iridium Corporation also tried to sound positive in an unattributed statement: "We continue to believe in the long term viability of the Iridium project and are confident that this approach will greatly strengthen Iridium's financial position and enable the company to succeed in the market."

But outside observers are more pessimistic. Professors Sheth and Sisodia are discouraged by the numbers. "Even if the company gets a million customers, it would have to net $1,000 a year from each of them just to pay its $1 billion annual operating costs." The failure of competitor ICO also casts doubts on Iridium's long-term viability. Indeed, the two bankruptcies have put pressure on the other companies with related business plans.

Among them is Globalstar, the only company in the satellite voice sector not operating under Chapter 11. Globalstar is taking a different approach by providing both cellular and satellite service from a single handset, and targeting under-served areas of the globe. "In the United States, for example, 35 percent of the land mass is not covered by cell," says Mac Jeffery, spokesperson for Loral Space & Communications, Globalstar's lead investor. "The number is 70 percent of Canada, and 90 percent of the world at large." The problem with those figures is that they don't reflect population. Most Canadian cities, for example, are close to the southern border, leaving vast land masses unpopulated. Cellular service doesn't have to cover every piece of earth to serve most of its inhabitants, and as cellular service broadens, the opportunity for satellite coverage will diminish.

Another company, Teledesic, is aiming for a different market-satellite-enabled broadband. The company is privately held, with investors that include Bill Gates, cellular phone mogul Craig McCaw, and Saudi Prince Alwaleed Bin Talal. Also investing is Motorola, the company that spawned Iridium.

While planning to launch satellites, Teledesic is not quite in Iridium's business because it is interested primarily in moving data, not voice conversations. "Teledesic is extending fiber-like capability to places that wouldn't receive such broadband services any other way," wrote Teledesic spokesman Roger Nyhus, in an e-mail correspondence. "The emerging technologies, which we applaud, are focused on the dense urban areas of the developed world. Teledesic's market extends broadband services - and corporate networks - to suburban and rural areas of the developed world as well as to all of the developing world. No other technology will do that."

Nyhus says that the company has raised more than $1.5 billion toward the development of the Teledesic Network-with about $10 billion needed for completion. He says that international investors understand the differences between Teledesic's services and markets and those of Iridium. "Teledesic's killer application is networking computers. We're developing, in effect, a 'Global Area Network' that will allow organizations to seamlessly interconnect all of their branch offices, suppliers, partners, employees and customers. This capability does not exist today globally - and won't until there's a satellite-based solution like Teledesic. The proliferation of terrestrial broadband technologies will only drive demand for Teledesic's service in parts of the world without such capability, which is most of the Earth's surface and most of the world's population."

Nyhus won't speculate on what these services will cost, except to predict that they will be competitive and profitable. Of course that's the game for every company-particularly those that take costly technological leaps. In an era when you can start a company out of your home with a Web site and a good idea, it is tempting to dismiss business plans that require huge amounts of capital. But while their failures are more spectacular, so are their successes. The lesson from Iridium is not to let your technology gains blind you to the cold realities of the market.

An interview with Mac Jeffery, spokesperson for Loral Space & Communications

Is it lonely at the top? Loral Space & Communications, the principal investor in Globalstar, ought to know. With its two chief rivals in bankruptcy, Globalstar faces a skeptical investment community that wonders whether this market will ever pay dividends. But the company also has strong backers, including China Telecom, DaimlerChrysler Aerospace, Hyundai, Qualcomm, and Vodafone AirTouch. To find out the company's strategy, I spoke with Loral spokesman Mac Jeffery.

How do you differ from Iridium?

We have a much lower cost structure than Iridium and the other vendor in this field. The infrastructure to build Globalstar was about half the price of Iridium and it has three times the capacity. So right off the bat we are at one-sixth of the overall investment.

Did you save money by smarter engineering or by waiting longer for the technology to improve?

A little of both. Iridium wanted to cover the entire globe, including the polar regions. We figured that covering the last 15 percent of the world is so enormous, it didn't add up. So we saved money that way. We also had the foresight to chose CDMA technology, which was unproven when we began, but is now totally accepted. CDMA has three times the capacity of TDMA, which is used by Iridium.

Was capacity an Iridium problem?

It affects their basic cost-which is why they were having to charg something like $7 a minute. We will be charging a wholesale rate of as low as 35 cents a minute. The retail end of that will be anywhere from $1 to $2, depending on from where to where you call. We believe people will pay an incremental extra service cost for satellite service but it must be reasonable.

The other big difference is the marketing structure. Iridium tried to do it all themselves-from development and manufacturing to end user sales. We're not a telephone company, we are a satellite communications company. So we shared the equity base with a number of established, very successful telephone companies-like Vodafone AirTouch, France Telecom, Alcatel, and China Telecom. These companies already have existing equipment and marketing infrastructures in place, so they will be able to offer Globalstar service as an adjunct to their existing business. So they are off and running from day one.

What about the limited access of this technology, the inability to transceive through an office or a car?

That's been a little overblown by the Iridium experience. First of all, Globalstar phones will have two modes: cellular, with satellite capability on top. When you turn on your Globalstar phone, it will first take the cheaper route and look for a cell, only going to satellite mode if it can't find one. So if you are in a metropolitan area that has any sort of cellular coverage, and you are in a building, you'll be able to make a call. Otherwise, you would have to be outside, or by a window. Unlike Iridium, we have something called "pass diversities"-which means that at least two, usually three and sometimes as many as four satellites will track you at the same time, from different angles in the sky. If you go over to a window, there's a really good chance that at least one of the satellites will be in sight from that window, and it will go through glass.

Are you worried that cellular technology will eventually catch up and en masse offer some kind of a universal service?

Cellular will eventually bridge the gap between the American and the European system. But will cellular build out to the where it covers the whole world? That's not going to happen for a very long time. We are not principally targeting markets like the U.S. or the U.K., although we will sell a fair number in those markets. The real opportunities for us are in developing countries like Brazil and India. You can get cell coverage in downtown Sao Paolo, but if you go 20 miles outside the city, you're off the air.

That's a significant difference from Iridium which targeted global road warriors.

Exactly. That's a pretty small market, and most of those people are going from Tokyo to Hong Kong to London. There will always be cell service in those cities. We're targeting a much broader market of average business people and vertical markets like maritime, mining, forestry-people who operate in remote locations and they don't have access to cell, or in some cases, any phone service. Maritime is particularly interesting because there is no cell service that reaches more than 30 miles off shore. Globalstar reaches, effectively, hundreds of miles off shore.

Does Globalstar have its own satellites?

Yes, we have a constellation of 48. Iridium has 66.

Are Iridium's satellites up there for the taking?

They are, and people asked if we might buy them. But what would we do we do with them? They are utterly an different technology-it's like AM and FM. Yes, they are up there, and they might go cheap, but we have no use for them.

Is Globalstar the last company standing unbruised in this business?

That's us. The ICO bankruptcy was surprising to us because they never got out of the starting gate-they hadn't launched anything yet.

It must be putting some pressure on you in terms of raising funds because people are suspicious of the sector.

Yes, except we have the good fortune of having raised all the funds. We got ahead of the game and in early August completed the last of the funding we will require.

When will you begin offering service?

We will start rolling out service the end of September. It will be gradual. One lesson we learned from Iridium is we don't want to rush this out the door before it is ready. Even though Iridium's satellite constellation was in place, they slipped up on more down-to-earth things like a lack of phones and no customer help desk. Our satellites are up and running and have been tested for close to a year now, versus Iridium, which gave it a month. At the end of September, we will be offering services in very limited quantities for select markets. The service providers will be hand-picking a testbed of outside customers. But it will be real working service.

We take heart in that our partners have all done this before. AirTouch, for example, has launched new products and new technologies before and they know better than us what they should and should not do in rolling a service out like this.

Have you announced any expectations about subscriber volumes?

We've set two milestones. By the middle of next year we are aiming for 220,000 subscribers worldwide. If you slice it up by all the markets we're in, that's not overly ambitious-it puts us at a break-even level for our operating costs. And by the end of 2001, we hope to have 1.8 million subscribers. Our total break-even point for everything is at a million subscribers, and the system has a capacity for 7.5 million.

How sure are you of making those numbers?

We've done our own market research. What really gives us heart is our service providers. They know the market, have given us projections, and continue to update their projections based on their record of their expertise in these markets. And they continue to back up those two milestones.